Other Ways to Supplement Your Retirement Income

Comparing Tax-Advantaged Investing to Other Investing

By comparing the different tax-advantaged ways to save, you can make an informed decision of where to save for retirement. Following is an example that compares a tax-free Roth IRA to a 401(k) plan to a taxable savings account.

SUGGESTION: The financial advantage of contributing to a tax-free or tax-deferred account versus a regular savings account is significant. Let's look at an example of the difference.

Assumptions:

  • Employee saves $28/week (equivalent to approximately $37/week on a pre-tax basis)
  • Investment will earn 6%/year
  • Employee's tax rate is 25%
 

Savings in a Tax Free Roth IRA

Savings in a Pre-tax 401(k) Plan

Taxable Savings*

5 years

$8,408

$11,211

$8,214

10 years

$19,757

$26,342

$18,812

15 years

$35,073

$46,764

$32,487

20 years

$55,744

$74,325

$50,132

*Assuming a tax rate of 15% on long-term capital gain

The taxable savings account is clearly the least favorable way to save for retirement. The pre-tax 401(k) plan appears to be the winner; however, upon withdrawal in retirement, the money would be taxed at your ordinary tax rate. The Roth IRA balance would not be taxed upon withdrawal. Let's assume your marginal federal tax rate in retirement is 15%. After 20 years of savings, the Roth IRA would be worth $55,744 upon withdrawal while the 401(k) plan would be worth $63,176, after taxes, upon withdrawal.

 

SUGGESTION: If you are evaluating an investment and it will earn a similar rate of return either inside or outside of a tax-free or tax-deferred plan, depending on your tax bracket, it may be better to invest within a tax-advantaged plan. But keep in mind that the money invested on a tax-advantaged basis is generally restricted until age 59½. As an alternative, sometimes investing in growth stocks or growth mutual funds can achieve results similar to tax-deferred investing.

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